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Stock returns and the Miller Modigliani valuation formula: Revisiting the Fama French analysis*

* This paper is a replication of an original study

Author

Listed:
  • Aharoni, Gil
  • Grundy, Bruce
  • Zeng, Qi

Abstract

Fama and French (2006) use the dividend-discount model to develop the role of expected profitability, expected investment, and the book-to-market ratio as predictors of stock returns. One reported empirical result is anomalous. The valuation model establishes that the comparative static relation between expected returns and expected investment is negative, yet it appears to be positive and insignificant. We show that the posited valuation relations apply at the firm level, and not at the per share level at which they were tested. Once the variables are measured at the firm level, all the Fama French predictions are validated.

Suggested Citation

  • Aharoni, Gil & Grundy, Bruce & Zeng, Qi, 2013. "Stock returns and the Miller Modigliani valuation formula: Revisiting the Fama French analysis," Journal of Financial Economics, Elsevier, vol. 110(2), pages 347-357.
    • Handle: RePEc:eee:jfinec:v:110:y:2013:i:2:p:347-357
    DOI: 10.1016/j.jfineco.2013.08.003
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    References listed on IDEAS

    as
    1. Eugene F. Fama & Kenneth R. French, 2008. "Dissecting Anomalies," Journal of Finance, American Finance Association, vol. 63(4), pages 1653-1678, August.
    2. Michael J. Cooper & Huseyin Gulen & Michael J. Schill, 2008. "Asset Growth and the Cross‐Section of Stock Returns," Journal of Finance, American Finance Association, vol. 63(4), pages 1609-1651, August.
    3. Jeffrey Pontiff & Artemiza Woodgate, 2008. "Share Issuance and Cross‐sectional Returns," Journal of Finance, American Finance Association, vol. 63(2), pages 921-945, April.
    4. Haugen, Robert A. & Baker, Nardin L., 1996. "Commonality in the determinants of expected stock returns," Journal of Financial Economics, Elsevier, vol. 41(3), pages 401-439, July.
    5. John M. Griffin & Michael L. Lemmon, 2002. "Book‐to‐Market Equity, Distress Risk, and Stock Returns," Journal of Finance, American Finance Association, vol. 57(5), pages 2317-2336, October.
    6. Novy-Marx, Robert, 2013. "The other side of value: The gross profitability premium," Journal of Financial Economics, Elsevier, vol. 108(1), pages 1-28.
    7. Loughran, Tim & Ritter, Jay R, 1997. "The Operating Performance of Firms Conducting Seasoned Equity Offerings," Journal of Finance, American Finance Association, vol. 52(5), pages 1823-1850, December.
    8. Fama, Eugene F. & French, Kenneth R., 2005. "Financing decisions: who issues stock?," Journal of Financial Economics, Elsevier, vol. 76(3), pages 549-582, June.
    9. Loughran, Tim & Ritter, Jay R, 1995. "The New Issues Puzzle," Journal of Finance, American Finance Association, vol. 50(1), pages 23-51, March.
    10. Titman, Sheridan & Wei, K. C. John & Xie, Feixue, 2004. "Capital Investments and Stock Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(4), pages 677-700, December.
    11. Evgeny Lyandres & Le Sun & Lu Zhang, 2008. "The New Issues Puzzle: Testing the Investment-Based Explanation," The Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2825-2855, November.
    12. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    13. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    14. Eugene F. Fama & Kenneth R. French, 2008. "Average Returns, B/M, and Share Issues," Journal of Finance, American Finance Association, vol. 63(6), pages 2971-2995, December.
    15. Brav, Alon & Geczy, Christopher & Gompers, Paul A., 2000. "Is the abnormal return following equity issuances anomalous?," Journal of Financial Economics, Elsevier, vol. 56(2), pages 209-249, May.
    16. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411-411.
    17. Fama, Eugene F & French, Kenneth R, 1995. "Size and Book-to-Market Factors in Earnings and Returns," Journal of Finance, American Finance Association, vol. 50(1), pages 131-155, March.
    18. Fama, Eugene F. & French, Kenneth R., 2006. "Profitability, investment and average returns," Journal of Financial Economics, Elsevier, vol. 82(3), pages 491-518, December.
    Full references (including those not matched with items on IDEAS)

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    Replication

    This item is a replication of:
  • Fama, Eugene F. & French, Kenneth R., 2006. "Profitability, investment and average returns," Journal of Financial Economics, Elsevier, vol. 82(3), pages 491-518, December.

    • More about this item

    Keywords

    Book-to-market; Profitability; Investment; Expected return;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    Lists

    This item is featured on the following reading lists, Wikipedia, or ReplicationWiki pages:
    1. Stock returns and the Miller Modigliani valuation formula: Revisiting the Fama French analysis (JFE 2013) in ReplicationWiki

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